By keeping separate finances, this California couple thought they had insulated the wife from the financial woes of her entrepreneur husband.
They didn’t share bank accounts nor credit cards while she carefully kept her distance from his business dealings. Her name was not on anything tied to his business.
But “separate” isn’t enough to overcome California community property law. Only a written agreement that explicitly changes the character of assets acquired during marriage defeats the community property presumption. That presumption holds:
Assets acquired during marriage are presumed to be community property.
And community property is liable for the debts of either spouse, incurred before or during marriage.
Central to this story, when husband’s business failed and bankruptcy became necessary, all of the community property becomes property of the estate when he spouse files bankruptcy.
Bankruptcy rule for community property
The bankruptcy code specifically provides that a bankruptcy filing brings all of a couple’s community property into the bankruptcy estate. Even if only one spouse files bankruptcy.
All of the creditors who have claims against either spouse can file a claim if there will be funds for creditors in the case. And the bankruptcy discharge will protect future community property from any creditor of either spouse whose claim existed when the case was filed.
Spouse’s wages are community
Community property includes the wages of either spouse. So, my client faces having her earned but unpaid wages subject to the bankruptcy case along with her profit sharing plan and stock purchase plan.
California law creates a small safe harbor for wages that keeps creditors of the other spouse from reaching her wages, but only if the debt arose before marriage and the wages are deposited in a separate account to which her husband has no access.
That’s no help when the failing business operated during their marriage.
Name on title is irrelevant
A widespread myth about creditor’s rights holds that a creditor can only reach property that is titled to the person who owes the debt. That’s why lay people think they can change the way title stands to significant assets and protect the asset no longer in their name from creditors.
Under California law, the character of property as community is not dependent on who hold title. Rather its character flows from when it was acquired and whether there is a valid prenuptial agreement or transmutation agreement.
Clear, written agreement required
Which brings us to the statutory requirements to overcome the presumption that an asset acquired during marriage is not community property: 1) a written agreement, 2) signed by both parties, that 3) unequivocally shows intent to change the character of property.
The California Supreme Court’s decision in Brace enforced the statutory requirements for transmutation to find that a deed to real property that said the spouses held as joint tenants, not community property, was insufficient to defeat the presumption.
Presume at your peril
So, our couple who religiously kept their finances separate failed to insulate one spouse from the debts of the other. In the absence of a valid written agreement, everything they acquired during marriage was community property. And community property was exposed to the debts of either spouse.
Moral of the story: it isn’t enough to walk the walk, if you didn’t commit the talk to paper first.